The Most Important Question to Ask a Beneficiary

By Beverly DeVeny, IRA Technical Expert
Follow Me on Twitter: @BevIRAEdSlott

A new client calls or comes to your office. They tell you that they have just inherited retirement assets from their parent, spouse, sibling, friend – it doesn’t matter who. What is the first and most important question you ask them?

WERE YOU NAMED ON THE BENEFICIARY FORM?
 

Why ask this question? The rules are generally very favorable for a beneficiary who was named on the form (or one who was named by the defaults in the IRA agreement or employer plan document). These beneficiaries are called designated beneficiaries. The rules are generally not so favorable for beneficiaries who inherit through the will or estate –  non-designated beneficiaries.

A non-designated IRA beneficiary cannot use their own life expectancy for calculating required minimum distributions (RMDs) on the inherited IRA. If the account owner died before their required beginning date (April 1 of the year after they turn age 70 ½), then the inherited account must pay out within five years. If the account owner died after their required beginning date, then the beneficiary can take distributions over the deceased account owner’s remaining life expectancy, had they lived.

A non-designated employer plan beneficiary cannot transfer the inherited plan assets to an inherited IRA. They will have to use the distribution options available in the plan, which could be as short as a total payout within one year.

Contrast those options to the options available to a designated beneficiary. A designated beneficiary can set up an inherited IRA and take required distributions using their own life expectancy. As long as the beneficiary is under the age of 90 (the life expectancy factor for a 90 year old is 5.5), the designated beneficiary generally will be able to stretch distributions out over a much longer period than a non-designated beneficiary.

The designated beneficiary has immediate access to the inherited IRA although the IRA custodian may have paperwork that must be completed before he or she actually has access to the funds. A non-designated beneficiary must wait for the estate to be probated. The IRA can become available to creditors of the estate before it gets to the non-designated beneficiary or it could be held up by competing claims for the asset.

There are a few things that all beneficiaries have in common. Any distributions made payable to a beneficiary, either designated or non-designated will be taxable. They cannot be put back into a retirement account. Beneficiaries cannot do a 60-day rollover of inherited retirement assets unless they are the spouse of the decedent.

Beneficiaries can only move inherited retirement assets in a direct transfer. Beneficiaries never have to pay an early distribution penalty on distributions from the inherited account. Beneficiaries, including Roth IRA beneficiaries, generally must begin to take RMDs beginning in the year after the death of the account owner unless they are the spouse or they are using the five-year rule.